CHAPTER 1 INTRODUCTION

The seventh largest and second most populous country in the world, India has long
been considered a country of unrealized potential. A new spirit of economic
freedom is now stirring in the country, bringing sweeping changes in its wake. A
series of ambitious economic reforms aimed at deregulating the country and
stimulating foreign investment has moved India firmly into the front ranks of the
rapidly growing Asia Pacific region and unleashed the latent strengths of a
complex and rapidly changing nation.

India's process of economic reform is firmly rooted in a political consensus that

spans her diverse political parties. India's democracy is a known and stable factor,
which has taken deep roots over nearly half a century. Importantly, India has no
fundamental conflict between its political and economic systems. Its political
institutions have fostered an open society with strong collective and individual
rights and an environment supportive of free economic enterprise.

India's time tested institutions offer foreign investors a transparent environment

that guarantees the security of their long term investments. These include a free
and vibrant press, a judiciary which can and does overrule the government, a
sophisticated legal and accounting system and a user friendly intellectual
infrastructure. India's dynamic and highly competitive private sector has long been
the backbone of its economic activity. It accounts for over 75% of its Gross
Domestic Product and offers considerable scope for joint ventures and
collaborations.

Today, India is one of the most exciting emerging money markets in the world.
Skilled managerial and technical manpower that match the best available in the
world and a middle class whose size exceeds the population of the USA or the
European Union, provide India with a distinct cutting edge in global competition.
The average turnover of the money market in India is over Rs. 40,000 crores daily.
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This is more than 3 percent of the total money supply in the Indian economy and 6
percent of the total funds that commercial banks have let out to the system. This
implies that 2 percent of the annual GDP of India gets traded in the money market
in just one day. Even though the money market is many times larger than the
capital market, it is not even fraction of the daily trading in developed markets.

Meaning

Money market refers to the market where money and highly liquid marketable
securities are bought and sold having a maturity period of one or less than one
year. It is not a place like the stock market but an activity conducted by telephone.
The money market constitutes a very important segment of the Indian financial
system. The highly liquid marketable securities are also called as money market
instruments like treasury bills, government securities, commercial paper,
certificates of deposit, call money, repurchase agreements etc.

The major player in the money market are Reserve Bank of India (RBI), Discount
and Finance House of India (DFHI), banks, financial institutions, mutual funds,
government, big corporate houses. The basic aim of dealing in money market
instruments is to fill the gap of short-term liquidity problems or to deploy the
short-term surplus to gain income on that.

The money market is a market for lending and borrowing of short-term

funds.

Money market deals in funds and financial instrument having a maturity

period of one day to one year.

The instruments in the money market are close substitutes for money as they
are of short-term nature and highly liquid.

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 Money market is not a place (like the stock market). It is in fact, a
mechanism undertaken by telephone.

Also, it is a collection of markets for several financial instruments such as

call money market, commercial bill market, etc

Definition

According to the McGraw Hill Dictionary of Modern Economics, money market

is the term designed to include the financial institutions which handle the purchase,
sale, and transfers of short term credit instruments. The money market includes the
entire machinery for the channelizing of short-term funds. Concerned primarily
with small business needs for working capital, individuals borrowings, and
government short term obligations, it differs from the long term or capital market
which devotes its attention to dealings in bonds, corporate stock and mortgage
credit.

Following definitions will help us to understand the concept of money market.

According to the Reserve Bank of India, money market is the centre for dealing,
mainly of short term character, in money assets; it meets the short term
requirements of borrowings and provides liquidity or cash to the lenders. It is the
place where short term surplus investible funds at the disposal of financial and
other institutions and individuals are bid by borrowers agents comprising
institutions and individuals and also the government itself.

These definitions help us to identify the basic characteristics of a money market. A

money market comprises of a well-organized banking system. Various financial
instruments are used for transactions in a money market. There is perfect mobility

3
of funds in a money market. The transactions in a money market are of short term
nature.

History

Till 1935, when the RBI was set up the Indian money market remained highly
disintegrated, unorganized, narrow, shallow and therefore, very backward. The
planned economic development that commenced in the year 1951 market an
important beginning in the annals of the Indian money market. The nationalization
of banks in 1969, setting up of various committees such as the Sukhmoy
Chakravarty Committee (1982), the Vaghul working group (1986), the setting up of
discount and finance house of India ltd. (1988), the securities trading corporation
of India (1994) and the commencement of liberalization and globalization process
in 1991 gave a further fillip for the integrated and efficient development of India
money market.

Sukhumoy Chakravarty Committee

The call money market for India was first recommended by the Sukhumoy
Chakravarty .Committee was set up in 1982 to review the working of the monetary
system. They felt that allowing additional non-bank participants into the call
market would not dilute the strength of monetary regulation by the RBI, as
resources from non-bank participants do not represent any additional resource for
the system as a whole, and their participation in call money market would only
imply a redistribution of existing resources from one participant to another. In view
of this, the Chakravarty Committee recommended that additional nonbank
participants may be allowed to participate in call money market.

The Vaghul Committee

The Vaghul Committee (1990), while recommending the introduction of a number

of money market instruments to broaden and deepen the money market,

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recommended that the call markets should be restricted to banks. The other
participants could choose from the new money market instruments, for their short
-term requirements. One of the reasons the committee ascribed to keeping the call
markets as pure inter-bank markets was the distortions that would arise in an
environment where deposit rates were regulated, while call rates were market
determined.

Objectives of Money Market

Money market is an important part of the economy. It plays very significant

functions. As mentioned above it is basically a market for short term monetary
transactions. Thus it has to provide facility for adjusting liquidity to the banks,
business corporations, non-banking financial institutions (NBFs) and other
financial institutions along with investors.

A well-developed money market serves the following objectives:

Providing an equilibrium mechanism for ironing out short-term surplus and

deficits. It means to keep a balance between the demand for and supply of
money for short term monetary transactions.
Providing a focal point for central bank intervention for the influencing
liquidity in the economy.
Providing access to users of short-term money to meet their requirements at
a Reasonable price

To promote economic growth. Money market can do this by making funds

available to various units in the economy such as agriculture, small scale
industries, etc.

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 To provide help to Trade and Industry. Money market provides adequate
finance to trade and industry. Similarly it also provides facility of
discounting bills of exchange for trade and industry.

To help in implementing Monetary Policy. It provides a mechanism for an

effective implementation of the monetary policy.

To help in Capital Formation. Money market makes available investment

avenues for short term period. It helps in generating savings and investments
in the economy.

Money market provides non-inflationary sources of finance to government.

It is possible by issuing treasury bills in order to raise short loans. However
this does not leads to increases in the prices.

Apart from those, money market is an arrangement which accommodates banks

and financial institutions dealing in short term monetary activities such as the
demand for and supply of money.

Scope of Money Market

The India money market is a monetary system that involves the lending and
borrowing of short-term funds. India money market has seen exponential growth
just after the globalization initiative in 1992. It has been observed that financial
institutions do employ money market instruments for financing short-term
monetary requirements of various sectors such as agriculture, finance and
manufacturing. The performance of the India money market has been outstanding
in the past twenty years.

Central bank of the country - the Reserve Bank of India (RBI) has always been
playing the major role in regulating and controlling the India money market. The

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intervention of RBI is varied - curbing crisis situations by reducing the cash
reserve ratio (CRR) or infusing more money in the economy.

Significance of Money Market

If the money market is well developed and broad based in a country, it greatly
helps in the economic development of a country. The central bank can use its
monetary policy effectively and can bring desired changes in the economy for the
industrial

and commercial progress in the country. The importance of money market is given,
in brief, as under:

(i) Financing Industry

A well-developed money market helps the industries to secure short term loans for
meeting their working capital requirements. It thus saves a number of industrial
units from becoming sick.

(ii) Financing trade

An outward and a well-knit money market system play an important role in

financing the domestic as well as international trade. The traders can get short term
finance from banks by discounting bills of exchange. The acceptance houses and
discount market help in financing foreign trade.

(iii) Profitable investment

The money market helps the commercial banks to earn profit by investing their
surplus funds in the purchase of. Treasury bills and bills of exchange, these short
term credit instruments are not only safe but also highly liquid. The banks can
easily convert them into cash at a short notice.

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(iv) Self-sufficiency of banks

The money market is useful for the commercial banks themselves. If the
commercial banks are at any time in need of funds, they can meet their
requirements by recalling their old short term loans from the money market.

(v) Effective implementation of monetary policy

The well-developed money market helps the central bank in shaping and
controlling the flow of money in the country. The central bank mops up excess
short term liquidity through the sale of treasury bills and injects liquidity by
purchase of treasury bills.

(vi) Encourages economic growth

If the money market is well organized, it safeguards the liquidity and safety of
financial asset. This encourages the twin functions of economic growth, savings
and investments.

(vii) Help to government

The organized money market helps the government of a country to borrow funds
through the sale of Treasury bills at low rate of interest The government thus
would not go for deficit financing through the printing of notes and issuing of more
money which generally leads to rise in an increase in general prices.

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(viii) Proper allocation of resources

In the money market, the demand for and supply of loan able funds are brought at
equilibrium the savings of the community are converted into investment which
leads to pro allocation of resources in the country.

Participants of the Money Market

The transactions in the money market are of high volume involving large amount.
So, money market is dominated by a small number of large players.

Some of the important players in the money market are:

Reserve Bank of India.

Discount and finance House of India.

Financial Institution.

Non-banking finance companies.

Securities Trading Corporation of India.

Public sector undertakings (PSU).

The role of important players in the money market is discussed below:

RESERVE BANK OF INDIA:

The reserve Bank of India is the most important player in the Indian Money
Market.

The Organized money market comes under the direct regulation of the RBI.

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 The RBI operates in the money market is to ensure that the levels of
liquidity and short-term interest rates are maintained at an optimum level so
as to facilitate economic growth and price stability.

RBI also plays the role of a merchant banker to the government. It issues
Treasury Bills and other Government Securities to raise funds for the
government.

The RBI thus plays the role of an intermediary and regulator of the money
market.

GOVERNMENT:

The Government is the most active player and the largest borrower in the
money market.

It raises funds to make up the budget deficit.

The funds may be raised through the issue of Treasury Bills (with a maturity
period of 91day/182day/364 days) and government securities.

CORPORATE FIRMS:

Corporate firms operate in the money market to raise short-term funds to

meet their working capital requirements.

They issue commercial papers with a maturity period of 7 days to 1 year.

These papers are issued at a discount and redeemed at face value on
maturity.

These corporate firms use both organized and unorganized sectors of money
market.

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BANKS:

Commercial Banks play an important role in the money market.

They undertake lending and borrowing of short term funds.

The collective operations of the banks on a day to day basis are very
predominant and hence have a major impact and influence on the interest
rate structure and the liquidity position.

FINANCIAL INSTITUTIONS:

Financial institutions also deal in the money market.

They undertake lending and borrowing of short-term funds.

They also lend money to banks by rediscounting Bills of Exchange.

Since, they transact in large volumes, they have a significant impact on the
money market.

INSTITUTIONAL PLAYERS:

They Consist of Mutual Funds, Foreign Institutional Players, Insurance

Firms, etc.

Their level of Participation depends on the regulations.

For instance the level of participation of the FIIs in the Indian money market
is restricted to investment in Government Securities.

DISCOUNT HOUSES AND PRIMARY DEALERS:

They are the intermediaries in the money market.

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 Discount Houses discount and rediscount commercial bill and Treasury
Bills.

Primary Dealers were introduced by RBI for developing an active secondary

market for Government securities.

They also underwrite Government Securities.

CHAPTER 2 STRUCTURE OF MONEY MARKET

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The Indian money market is divided into two parts namely organized and
unorganized. The organized sector consist of The Reserve Bank of India, Foreign
Banks, Commercial Banks, Co-operative banks, Discount and Finance House of
India, Mutual funds and finance Companies.

The Unorganized sector consists of indigenous bankers, money lenders, non-

banking financial intermediaries like chit funds, nidhis etc. this sector is a
heterogeneous sector. The organized sector of money market is well advanced. Its
principal centres are Mumbai, Kolkata, Delhi, Chennai, Ahmedabad, and
Bangalore. Of these centres the Mumbai centre is most active one.

ORGANIZED MONEY MARKET

The RBI is the apex institution which controls and monitors all the organizations
in the organised sector. The commercial banks can operate as lenders and
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operators. The FIs like IDBI, ICICI, and others operate as lenders. The organised
sector of Indian money market is fairly developed and organised, but it is not
comparable to the money markets of developed countries like USA, UK and Japan.

Main constituents of Organised Money Market

Reserve Bank of India

Reserve Bank of India is the regulator over the money market in India. As the
Central bank, it injects liquidity in the banking system, when it is deficient and
contracts the same in opposite situation.

Commercial Banks

Commercial Banks and the CO-operative banks are the major participants in
the Indian money market. They mobilize the savings of the people through
acceptance of deposits and lend it to business houses for their short term
working capital requirements. While a portion of these deposits is invested in
medium and long-term Government securities and corporate shares and bonds,
they provide short-term funds to the Government by investing in the Treasury
Bills. They employ the short-term surpluses in various money market
instruments.

Discount and Finance House of India Ltd. (DFHI)

DFHI deals both ways in the money market instruments. Hence, it

has helped in the growth of secondary market, as well as those of
the money market instruments.

Financial and Investment Institutions

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 These institutions (LIC, UTI, GIC, Development Banks, etc.) have
been allowed to participate in the call money market as lenders only.

Corporates

Companies create demand for funds from the banking system. They
raise short-term funds directly from the money market by issuing
commercial paper. Moreover, they accept public deposits and also
indulge in inter corporate deposits and investments.

Mutual Funds

Mutual funds also invest their surplus funds in various money

market instruments for short periods. They are also permitted to
participate in the Call Money Market. Money Market Mutual Funds
have been set up specifically for the purpose of mobilization of
short-term funds for investment in money market instruments.

UNORGANISED MONEY MARKET

The unorganized money market mostly finances short term financial needs of
farmers and small businessmen. The main constituents of unorganized Money
market are:

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 Indigenous Bankers (IBs)

The IBs are individuals or private firms who receive deposits and
give loans and thereby they operate as banks. Unlike moneylenders
who only lend money, IBs accept deposits as well as lend money.
They operate mostly in urban areas, especially in western and
southern regions of the country. Over the years, IBs faced stiff
competition from cooperative banks and commercial banks.
Borrowers are small manufacturers and traders, who may not be
able to obtain funds from the organised banking sector, may be due
to lack of security or some other reason.

Money Lenders (MLs)

MLs are important participants in unorganised money markets in

India. There are professional as well as nonprofessional MLs. They
lend money in rural areas as well as urban areas. They normally
charge an invariably high rate of interest ranging between 15% p.a.
to 50% p.a. and even more. The borrowers are mostly poor farmers,
artisans, petty traders, manual workers and others who require short
term funds and do not get the same from organised sector.

Chit Funds and Nidhis

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 They collect funds from the members for the purpose of lending to
members (who are in need of funds) for personal or other purposes.
The chit funds lend money to its members by draw of chits or lots,
whereas Nidhis lend money to its members and others.

Finance Brokers

They act as middlemen between lenders and borrowers. They

charge commission for their services. They are found mostly in
urban markets, especially in cloth markets and commodity markets.

Finance Companies

They operate throughout the country. They borrow or accept

deposits and lend them to others. They provide funds to small
traders and others. They operate like indigenous bankers.

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 CHAPTER 3 INSTRUMENTS OF MONEY MARKET

1. TREASURY BILLS (T-BILLS)

These are issued by the Reserve Bank of India on behalf of the Government of
India and are thus actually a class of Government Securities. At present, T-Bills are
issued in maturity of 14 days, 91 days and 364 days. The RBI has announced its
intention to start issuing 182 day T-Bills shortly. The minimum denomination can
be as low as Rs100, but in practice most of the bids are large bids from institutional
investors who are allotted T-Bills in dematerialized form. RBI holds auctions for
14 and 364 day T-Bills on a fortnightly basis and for 91 day T-Bills on a weekly
basis. For example a Treasury bill of Rs. 100.00 face value issued for Rs. 91.50
gets redeemed at the end of its tenure at Rs. 100.00. 91 days T-Bills are auctioned
under uniform price auction method whereas 364 days T-Bills are auctioned on the
basis of multiple price auction method. There is a notified value of bills available
for the auction of 91 day T-Bills which is announced 2 days prior to the auction.
There is no specified amount for the auction of 14 and 364 day T-Bills. The result

18
is that at any given point of time, it is possible to buy T-Bills to tailor ones
investment requirements.

Banks, Primary Dealers, State Governments, Provident Funds, Financial

Institutions, Insurance Companies, NBFCs, FIIs (as per prescribed norms), NRIs &
OCBs can invest in T-Bills.

Coupon terms

T-Bill is a discounted instrument and is issued in the form of a zero coupon

instrument at discount to face value redeemable at par on maturity.

Repayment

The amount on repayment is directly credited to the current account of the investor
held with RBI.

Risks on investment in T-Bills

Price risk. There is price risk due to interest rate sensitivity

Liquidity risk (in some maturity segments). It should be ensured that

investment in illiquid T-Bills may not be made for that maturity profile.

Counterparty risk. This is minimal due to DVP mode of settlement.

Operational risk. This is minimal and it is ensured that trades are confirmed
on the trade date itself and the settlement is done before the time prescribed
by RBI.

Reputation risk. The instances of SGL bouncing has reduced due to

introduction of Liquidity Adjustment Facility (LAF) by RBI. RBI has also
mentioned the introduction of Real Time Gross Settlement (RTGS) to avoid
such instances
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Taxation
The discount earned on T-Bills, as well as the profit/loss on investment is charged
under the head Income from Business and Profession. By virtue of proviso (iv)
to Section 193 of income tax act no tax is required to be deducted at source on
interest payable on any security of Central or State Government.(only for coupon
payments) No TDS is attracted on discount i.e. differential between issue price and
face value in case of treasury bills.

Potential investors have to put in competitive bids at the specified times. These
bids are on a price/interest rate basis. The auction is conducted on a French auction
basis i.e. all bidders above the cut off at the interest rate/price which they bid while
the bidders at the clearing/cut off price/rate get pro rata allotment at the cut off
price/rate. The cut off is determined by the RBI depending on the amount being
auctioned, the bidding pattern etc. By and large, the cut off is market determined
although sometimes the RBI utilizes its discretion and decides on a cut off level
which results in a partially successful auction with the balance amount devolving
on it. This is done by the RBI to check undue volatility in the interest rates.

Non-competitive bids are also allowed in auctions (only from specified entities like
State Governments and their undertakings and statutory bodies) wherein the bidder
is allotted T-Bills at the cut off price.

2. COMMERCIAL PAPER

The concept of CPs was originated in USA in early 19th century when commercial
banks monopolized and charged high rate of interest on loans and advances. In
India, the CP was launched in January 1990.

It is an unsecured money market instrument issued in the form of a promissory

note. CP was introduced in India in 1990 with a view to enabling highly rated
corporate borrowers to diversify their sources of short-term borrowings and to
provide an additional instrument to investors.

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These are issued by corporate entities in denominations of Rs2.5mn and usually
have a maturity of 90 days. CPs can also be issued for maturity periods of 180 and
one year but the most active market is for 90 day CPs.

Two key regulations govern the issuance of CPs-firstly, CPs have to be

compulsorily rated by a recognized credit rating agency and only those companies
can issue CPs which have a short term rating of at least P1. Secondly, funds raised
through CPs do not represent fresh borrowings for the corporate issuer but merely
substitute a part of the banking limits available to it. Hence, a company issues CPs
almost always to save on interest costs i.e. it will issue CPs only when the
environment is such that CP issuance will be at rates lower than the rate at which it
borrows money from its banking consortium.

Issuer Commercial Paper (CP)

Highly rated corporate borrowers, primary dealers (PDs) and satellite dealers
(SDs) and all-India financial institutions (FIs) which have been permitted to raise
resources through money market instruments under the umbrella limit fixed by
Reserve
Bank of India are eligible to issue CP.

A company shall be eligible to issue CP provided - (a) the tangible net worth of the
company, as per the latest audited balance sheet, is not less than Rs. 4 crore; (b) the
working capital (fund-based) limit of the company from the banking system is not
less than Rs.4 crore and (c) the borrower account of the company is classified as a
Standard Asset by the financing bank/s.

Commercial Papers when issued in Physical Form are negotiable by endorsement

and delivery and hence highly flexible instruments

Rating Requirement

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All eligible participants should obtain the credit rating for issuance of Commercial
Paper, from either the Credit Rating Information Services of India Ltd. (CRISIL)
or the Investment Information and Credit Rating Agency of India Ltd. (ICRA) or
the Credit Analysis and Research Ltd. (CARE) or the Duff & Phelps Credit Rating
India Pvt. Ltd. (DCR India) or such other credit rating agency as may be specified
by the Reserve Bank of India from time to time, for the purpose. The minimum
credit rating shall be P-2 of CRISIL or such equivalent rating by other agencies.
Further, the participants shall ensure at the time of issuance of CP that the rating so
obtained is current and has not fallen due for review.

Maturity
CP can be issued for maturities between a minimum of 15 days and a maximum up
to one year from the date of issue. If the maturity date is a holiday, the company
would be liable to make payment on the immediate preceding working day.
Denominations
CP can be issued in denominations of Rs.5 lakh or multiples thereof.

Investment in CP

CP may be issued to and held by individuals, banking companies, and insurance

companies, other corporate bodies registered or incorporated in India and
unincorporated bodies, Non-Resident Indians (NRIs) and Foreign Institutional
Investors (FIIs). However, investment by FIIs would be within the 30 per cent limit
set for their investments in debt instruments. Non-resident Indians can invest
in CPs on a non-repairable, non-transferable basis.

Trading

Trading is Over-the-counter or on the NSE. Market participants quote dealing

levels on yield basis specified up to two decimal places. For quotes on the NSE

22
equivalent prices up to 4 decimal prices need to be specified. Two way quotes are
rarely offered for Commercial Paper. Secondary market transactions do not attract
any stamp duty. There are no brokers in the Commercial Paper market.
Trading is done over the counter with the counterparties involved.

Mode of Issuance

CP can be issued either in the form of a promissory note or in a dematerialised

form through any of the depositories approved by and registered with SEBI. As
regards the existing stock of CP, the same can continue to be held either in physical
form or can be dematerialised, if both the issuer, and the investor agree for the
same.

How payment is received and made for CP

The initial investor in CP shall pay the discounted value of the CP by means of a
crossed account payee cheque to the account of the issuer through IPA (Issuing and
Paying Agent). On maturity of CP, when the CP is held in physical form, the holder
of the CP shall present the instrument for payment to the issuer through the IPA.
However; when the CP is held in demat form, the holder of the CP will have to get
it redeemed through depository and receive payment from the IPA.

What is the procedure of issuing CP?

Every issuer must appoint an IPA for issuance of CP. The issuer should disclose to
the potential investors its financial position as per the standard market practice.
After the exchange of deal confirmation between the investor and the issuer,
issuing company shall issue physical certificates to the investor or arrange for
crediting the CP to the investors account with a depository. Investors shall be
given a copy of IPA certificate to the effect that the issuer has a valid agreement
with the IPA and documents are in order.

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Coupon Terms

CP will be issued at a discount to face value as may be determined by the issuer

and redeemable at par on maturity.

Risks Involved

Liquidity risk: This risk is managed be laying down deal size limits for the
dealers, heads of desk and heads of groups.

Credit risk: This risk is managed by laying down counterparty limits based
upon the financial strength of the counterparty.

Operational risk: The risk involved in the operations of the issuer.

Taxation

The CBDT vide circular no 647 dated 22nd March 1993 has clarified that the
difference between the issue price and the face value of the Commercial Papers
and the Certificates of Deposits is to be treated as 'discount allowed' and not as
'Interest paid'. Hence, the provisions of the Income-tax Act relating to deduction of
tax at source are not applicable in the case of transactions in these two instruments.

3. COMMERCIAL BILLS
Bills of exchange are negotiable instruments drawn by the seller (drawer) of the
goods on the buyer (drawee) of the goods for the value of the goods delivered.
These bills are called trade bills. These trade bills are called commercial bills when
they are accepted by commercial banks. If the bill is payable at a future date and
the seller needs money during the currency of the bill then he may approach his
bank for discounting the bill. The maturity proceeds or face value of discounted
bill, from the drawee, will be received by the bank. If the bank needs fund during
the currency of the bill then it can rediscount the bill already discounted by it in the
commercial bill rediscount market at the market

24
related discount rate.

The RBI introduced the Bills Market scheme (BMS) in 1952 and the scheme was
later modified into New Bills Market scheme (NBMS) in 1970. Under the scheme,
commercial banks can rediscount the bills, which were originally discounted by
them, with approved institutions (viz., Commercial Banks, Development Financial
Institutions, Mutual Funds, Primary Dealer, etc.).

With the intention of reducing paper movements and facilitate multiple

rediscounting, the RBI introduced an instrument called Derivative Usance
Promissory Notes (DUPN). So the need for physical transfer of bills has been
waived and the bank that originally discounts the bills only draws DUPN. These
DUPNs are sold to investors in convenient lots of maturities (from 15 days up to
90 days) on the basis of genuine trade bills, discounted by the discounting bank.
Since some banks were using the facility of rediscounting commercial bills and
derivative usance promissory notes of as short a period as one day, the Reserve
Bank restricted such rediscounting to a minimum period of 15 days. The eligibility
criteria prescribed by the Reserve Bank for rediscounting commercial bills are that
the bill should arise out of a genuine commercial transaction showing evidence of
sale of goods and the maturity date of the bill should to exceed 90 days from the
date of rediscounting.

If the seller is in need of funds, he may draw a bill and send it to the buyer for
seller is in need of funds, he may draw a bill and send it to the buyer for
acceptance. The buyer accepts the bill and promises to make payment on the due
date. He may also approach his bank to accept the bill.

The bank charges a commission for the acceptance of the bill and promises to
make the payment if the buyer defaults. Once this process in accomplished, the
seller can sell it in the market. This way a commercial bill becomes a marketable
investment. Usually, the seller will go to the bank for discounting the bill. The
bank will pay him after deducting the interest for the remaining period of the bill
25
and service charges from the face value of the bill. The interest rate is called the
discount rate on the bills.

The commercial bill market is an important channel for providing short-term

finance to business. However, the instrument did not become popular because of
two factors:

1. Cash credit scheme is still the main form of bank lending, and

2. Big buyers in the corporate sector are still unwilling to the payment mode of
commercial bills.

Commercial bill is an important tool finance credit sales. It may be a demand bill
or a usance bill. A demand bill is payable on demand, that is immediately at sight
or on presentation by the drawee. A usance bill is payable after a specified time. If
the seller wishes to give sometime for payment, the bill would be payable at a
future date. These bills can either be clean bills or documentary bills. In a clean
bill, documents are enclosed and delivered against acceptance by drawee, after
which it becomes clear. In the case of a documentary bill, documents are delivered
against payment accepted by the drawee and documents of bill are filed by bankers
till the bill is paid.

4. CERTIFICATE OF DEPOSIT

These are issued by banks in denominations of Rs0.5mn. Banks are allowed to

issue CDs with a maturity of less than one year while financial institutions are
allowed to issue CDs with a maturity of at least one year. These are issued in
denominations of Rs.5 Lacs and Rs. 1 Lac thereafter. Bank CDs have maturity up
to one year. Minimum period for a bank CD is fifteen days. Financial Institutions
are allowed to issue CDs for a period between 1 year and up to 3 years. Usually,
this means 366 day CDs. The market is most active for the one year maturity
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bracket, while longer dated securities are not much in demand. One of the main
reasons for an active market in CDs is that their issuance does not attract reserve
requirements since they are obligations issued by a bank. They are like bank term
deposits accounts. Unlike traditional time deposits these are freely negotiable
instruments and are often referred to as Negotiable Certificate of Deposits. And are
also freely transferable by endorsement and delivery. At present CDs are issued in
physical form (in the form of Usance promissory note). CDs are not required
to be rated. CD is subject to payment of Stamp Duty under Indian Stamp Act,
1899 (Central Act).

All scheduled banks (except RRBs and Co-operative banks) and financial
institutions are eligible to issue CDs. They can be issued to individuals,
corporations, trusts, insurance companies, funds and associations. Non-resident
Indians can invest in CDs on a non-repatriable, nontransferable basis.
They are issued at a discount rate freely determined by the issuer and the
market/investors.

Rating
CDs are not required to be rated.

Coupon terms
CDs are issued at a discount to face value and are redeemable at par on maturity.

Trading medium
CDs are traded over the counter directly with the counterparty.

Risks Involved

Price risk/Interest rate risk

Liquidity risk

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 Credit risk Counter party risk is minimal since CD is a secure
instrument

Settlement Risk

Advantages:

1. Since one can know the returns from before, the certificates of deposits are
considered much safe.
2. One can earn more as compared to depositing money in savings account.
3. The Federal Insurance Corporation guarantees the investments in the
certificate of deposit.

Disadvantages:

1. As compared to other investments the returns is less.

2. The money is tied along with the long maturity period of the Certificate of
Deposit. Huge penalties are paid if one gets out of it before maturity.

3. Investors can redeem bank-issued CDs prior to maturity. However, you will
typically be charged an early withdrawal penalty. These penalties are set by
each bank and differ nationwide.
4. Unlike Treasury notes, the interest on CDs is not exempt from state and local
taxes. CDs are fully taxable at the state, local and federal levels.
5. The investment is locked in at a specific rate, even if interest rates increase.

5. REPO/REVERSE REPO

Meaning

Transaction in which 2 parties agree to sell & repurchase the same security. Under
such an agreement, the seller sells specified securities with an agreement to
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repurchase the same at a mutually decided future date and a price. The
Repo/Reverse repo transaction can only be done at Mumbai between parties
approved by RBI & in securities as approved by RBI (Treasury Bills, Central/State
Govt. Securities).

Definition

Repo is a transaction in which two parties agree to sell and repurchase the same
security. Under such an agreement the seller sells specified securities with an
agreement to repurchase the same at a mutually decided future date and a price

The security to a lender and promises to repurchase from him overnight. Hence the
Repos have terms ranging from 1 night to 30 days. They are very safe due
government backing.

A repurchase agreement is an agreement between a seller and a buyer in which

the seller agrees to repurchase the securities at an agreed upon rate. A holder of
securities sells repurchase agreements to an investor with an agreement to
repurchase them at a fixed price on a fixed date. The security buyer, in effect, lends
the seller money for the period of the agreement. The terms of the agreement are
structured to compensate the security buyer. Large amounts of money are needed
for this type of investment.

The Repo/Reverse Repo transaction can only be done at Mumbai between parties
approved by RBI and in securities as approved by RBI (Treasury Bills,
Central/State Govt securities).

Types of Repurchase Agreements

Overnight repurchase agreements, which mature the next day

Open repurchase agreements, which have undefined maturities. The rates
are variable or set daily; they roll or terminate at the request of either
party

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 Term repurchase agreements have a defined maturity date, a fixed rate,
and are liquid

Uses of Repo

Helps banks to invest surplus cash

Raising funds by borrowers
Adjusting SLR/CRR positions simultaneously.
For liquidity adjustment in the system.

The RBI achieves the function of maintaining liquidity in the money market
through REPOS / REVERSE REPOS.

The repo / reverse repo is a very important money market instrument to

facilitate short-term liquidity adjustment among banks, financial institutions
and other money market players.

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 A repo / reverse repo is a transaction in which two parties agree to sell and
repurchase the same security at a mutually decided future date and price.

From the sellers point of view, the transaction is called a repo; whereby the
seller gets immediate funds by selling the securities with an agreement to
repurchase the same at a future date.

Similarly, from the buyers point of view, the transaction is called a reverse
repo, whereby the purchaser buys the securities with an agreement to resell
the same at a future date.

The RBI, commercial banks and primary Dealers deal in the repos and
reverse repo transactions.

The financial institutions can deal only in the reverse repo transactions i.e.
they are allowed only to lend money through reverse repos to the RBI, other
banks and Primary dealers.

The maturity date varies from 1 day to 14 days.

The two types of repos are:

a. Inter-bank repos (the transaction takes place between banks and DFHI).

b. RBI repos (The repos / reverse repos are undertaken between banks and the
RBI to stabilize and maintain liquidity in the market).

6. INTER BANK PARTICIPATION

Participation certificates are a new form of credit instrument whereby banks can
raise funds from other banks and other central bank approved financial institutions

31
to ease liquidity. In this case banks have the option to share their credit asset(s)
with other banks by issuing participation certificates. With this participation
approach, banks and financial institutions come together either on risk sharing or
non-risk sharing basis. While providing short term funds, participation certificates
can also be used to reduce risk. The rate at which these certificates can be issued
will be negotiable depending on the interest rate scenario.

Inter-Bank Participation Certificates are instruments issued by scheduled

commercial banks only to raise funds or to deploy short term surplus. This
instrument is issued as per RBI guidelines for two purposes:
a. on risk sharing basis
b. without risk sharing
Inter-Bank Participation without risk sharing can have tenure of 90 days only
where, the issuing bank as borrowing and the participating bank advances to the
banks. In case of risk sharing basis, the lender bank shares losses with the
borrowing banks by mutually determining the interest rate. The tenure may be for
90 to 180 days.

7. MONEY MARKET MUTUAL FUNDS

Purpose of Money Market Mutual Funds for Investors

There are three instances when money market mutual funds, because of
their liquidity, are particularly suitable investments.

1. Money market mutual funds offer a convenient parking place for cash
reserves when an investor is not quite ready to make an investment or is
anticipating a near-term cash outlay for a non-investment purpose. Money
market mutual funds offer ultimate safety and liquidity. This means that

32
 investors will have an expected sum of cash at the very moment that they
need it.

2. An investor holding a basket of mutual funds from a single fund

company may occasionally want to transfer assets from one fund to another.
If, however, the investor wants to sell a fund before deciding on another
fund to purchase, a money market mutual fund offered by the same fund
company may be a good place to park the proceeds of sale. Then, at the
appropriate time, the investor may exchange his or her money market mutual
fund holdings for shares of the other funds in the fund family.

3. To benefit their clients, brokerage firms regularly use money market mutual
funds to provide cash management services. Putting a client's dormant cash
into money market mutual funds will earn the client an extra percentage
point (or two) in annual returns above those earned by other possible
investments.

Types of Money Market Mutual Funds

Money market funds are of two types:

1. Institutional Money Market Mutual Funds:

These funds are held by governments, institutional investors and businesses etc.
Huge sum of money is parked in institutional money funds.

2. Retail Money Market Mutual Funds:

Retail money market funds are used for parking money temporarily. The
investment portfolio of money market funds comprises of treasury bills, short term
debts, and tax free bonds etc.

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 Special Features of Money Market Mutual Funds

Money market mutual funds are one of the safest instruments of investment
for the retail low income investor. The assets in a money market fund are invested
in safe and stable instruments of investment issued by governments, banks and
corporations etc.

Generally, money market instruments require huge amount of investments

and it is beyond the capacity of an ordinary retail investor to invest such large
sums. Money market funds allow retail investors the opportunity of investing in
money market instrument and benefit from the price advantage.

Money market mutual funds are usually rated by the rating agencies.

8. CALL/ NOTICE MONEY MARKET

Call Money, Notice Money and Term Money markets are sub-markets of the
Indian Money Market. These refer to the markets for very short term funds.
Call Money refers to the borrowing or lending of funds for 1 day. Notice Money
refers to the borrowing and lending of funds for 2-14 days. Term money refers to
borrowing and lending of funds for a period of more than 14 days. Notice Money
is also known as Short Notice Money.

Interest Rates in Call / Notice Money Markets Interest rates in these markets are
market determined i.e. by the demand and supply of short term funds. In India,
80% demand comes from the public sector banks and rest 20% comes from foreign
and private sector banks. Then, around 80% of short term funds are supplied by
34
Financial Institutions such as IDBI and Insurance giants such as LIC. Rest 20% of
the short term funds come from the banks. Since banks work as both lenders and
borrowers in these markets, they are also known as Inter-Bank market. The short
term fund market in India is located only in big commercial centres such as
Mumbai, Delhi, Chennai and Kolkata. The intervention of RBI is prominent in the
short term funds money market in India. Call Money / Notice Money market is
most liquid money market and is indicator of the day to day interest rates. If the
call money rates fall, this means there is a rise in the liquidity and vice versa.

CHAPTER 4 LIMITATIONS

Some of the important drawbacks of Indian Money Market are:-

1. MULTIPLE RATE OF INTEREST: In the Indian money market, especially

the banks, there exists too many rates of interests. These rates vary for lending,

35
 borrowing, government activities, etc. Many rates of interests create confusion
among the investors.

2. DICHOTOMY: Dichotomy i.e. existence of two markets (organized money

market and unorganized money market) is a major defect of the Indian Money
Market. The unorganized money market comprises of indigenous bankers,
moneylenders, chit funds, nidhis, loan companies and finance brokers that do
not come under the control and supervision of the RBI. This unorganized sector
is mainly concentrated in the rural areas and it does not differentiate between
short term and long term finance and between the purposes of finance. This puts
a limit on the RBIs control over the money market.

3. LACK OF INTEGRATION: The RBI finds it difficult to integrate the

organized and the unorganized money market. While the RBI can control and
supervise the working of the organized sector effectively, the heterogeneous
unorganized sector is out of RBIs control. There is no uniformity in the
practices and operations of the unorganized money market. Moreover, the
interest rates in both the markets are also different. Thus there is lack of
integration in the Indian money market.

4. MULTIPLICITY IN INTEREST RATES: There is diversity in rates of

interest in the Indian money market. This multiplicity in the interest rates is due
to lack of mobility of funds from one section of the money market to another.
The rates differ from institution to institution even for funds of the same
duration. Although the wide differences are being narrowed down, the existing
differences do hamper the efficiency of the money market.

5. ABSENCE OF ORGANISED BILL MARKET: The existence of a well-

organized bill market is essential for effective linking up various credit
agencies. It refers to a mechanism where bills of exchange are purchased and

36
 discounted by commercial banks / financial institutions. The bill market is not
yet developed in India due to the following reasons:

Banks keeping large amount of cash.

Preference for borrowing rather than discounting bills.

Overdependence on cash / cheque transactions.

High stamp duty on usance bill, etc.

6. SHORTAGE OF FUNDS: The Indian money market is characterized by

shortage of funds. Various factors like inadequate banking facilities, low
savings, lack of banking habits, existence of parallel economy etc lead to
shortage offends. Thus, demand for short-term funds far exceeds the supply.
This results in high interest rate. However now banks are flush with funds
especially in urban area as people prefer to invest their money with banks rather
than keeping them as deposits in the unorganized sector.

7. SEASONAL STRINGENCY OF MONEY: Since agriculture continues to

play a major role in the Indian economy, farm operations do influence the
demand for and supply of money. Thus seasonal stringency of money and high
interest rate during the busy season (November to June) is a striking feature of
the Indian money market. Also, there a wide fluctuations in the interest rates
from one reason to another. However, the RBI makes attempt to reduce the
fluctuations by adding money into the money market during the busy season
and withdrawing the funds during the slack season.

8. INADEQUATE CREDIT INSTRUMENTS: The Indian money market

lacked adequate short-term paper instruments till1985-86. Only call money
market and bill market existed. Also there were no specialized dealers / brokers
in the money market. After 1985-86 the RBI Introduced new credit instruments
37
 in the market like CDs, CPs, MMMF etc but they are not yet fully developed in
India.

9. ABSENCE OF a WELL-ORGANISED BANKING SECTOR IN

RURALAREA: There is poor banking system in the rural area due to the
problems of overheads and maintenance of branches. The commercial bank
branches in rural area are only 40% of the total bank branches. This also
hampers the development of money market in India.

10.INEFFICIENT AND CORRUPT MANAGEMENT: Faulty selection, lack of

training, poor performance appraisal and faulty promotions result in
inefficiency and corruption in the banking sector. This adversely affects the
success and performance of money market. These are some of the major
drawbacks of the Indian money market; many of these are also the features of
our money market.

CHAPTER 5 CONCLUSION

The money market is a vibrant market, affecting our everyday lives. As the short-
term market for money, money changes hands in a short time frame and the players
in the market have to be alert to changes, up to date with news and innovative with
strategies and products. The withdrawal of non-bank entities from the inter-bank
call-money market is linked to the improvement of settlement systems. Any time-

38
bound plan for the evolution of a pure inter-bank call/notice money market would
be ineffective till the basic issue of settlements is addressed.

In brief, various policy initiatives by the Reserve Bank have facilitated

development of a wider range of instruments such as market repo, interest rate
swaps, CDs and CPs. This approach has avoided market segmentation while
meeting demand for various products. These developments in money markets have
enabled better liquidity management by the Reserve Bank.

Bibliography

http://www.gktoday.in/blog/call-money-notice-money-and-term-money-
market-in-india/

http://www.investopedia.com/articles/mutualfund/04/081104.asp

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 https://moneymarkettalk.wordpress.com/tag/inter-bank-participation-
certificates/

http://www.investorwords.com/477/bill_of_exchange.html

https://en.wikipedia.org/wiki/Money_market_fund

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